The High Tech Scene in Israel

Today’s High Tech Scene in Israel
By Brian L. Ginsler and Prof. Liora Katzenstein, President, ISEMI - Entrepreneurship in Israel

Describe Israel as a powerhouse of high tech innovation, and you may get some blank stares. Mention Mirabilis, better known for ICQ - the instant messaging system - and you’ll get a look reserved for high tech legends. For those of you still in the dark, the Mirabilis story is the stuff that high tech fairy tales are made of. Founded in July 1996 by four young Israelis with a good idea and the will to work around the clock, the company attracted huge numbers of users in record time, and was bought out within two years by AOL for $487 million. Ah, that ICQ!

Israel’s High Tech Industry is considered by many to be the second Silicon Valley, ranking immediately after North America in the number of companies (±120) listed on NASDAQ. The start-up community, numbering approximately 3000 companies, is making itself felt in most technological fields: medical devices and imaging, semiconductor manufacturing systems, advanced chip design, networking and communications systems, wireless communication solutions, security software solutions, enterprise software solutions, and cutting edge Internet applications.

Approximately 2,000 companies get added to this community each year, causing Israel to have the second highest number, in absolute terms, of startup firms worldwide, after the U.S.

Israeli start-ups also excel in the development of niche markets products, including OEM products and products that complete the lines being offered by industry giants. Ranging in size from one lone entrepreneur with only his guts and vision, to firms employing hundreds of highly skilled technical personnel, these crucibles of energy, determination, and innovation have sprung up like mushrooms across the country, utilizing the multi-faceted talents and original thinking of a multi-national population. Some of the best known examples of Israeli success stories, in addition to ICQ, include Checkpoint, Memco, and New Dimension.

Historical necessity has forced this tiny country, with a total area of 8400 sq. miles and a total population of 8 million, to become a technological powerhouse. Surrounded by enemies on all sides, suffering embargoes by major suppliers, Israel had no choice but to develop a strong and innovative military industry and to assure its superiority in fields such as electronics and communications.

Israel’s proclivity for learning and education nurtured this creativity. Developments in military technology are now being translated into exciting new products for the international marketplace.

Demobilized soldiers who served in elite technology units, together with Russian immigrants who arrived in Israel with their scientific and technological know-how, have burst onto the scene, offering a steady stream of new ideas and the energy required to actualize them.

Whereas in 1960, 70% of Israeli exports were oranges and other agricultural goods, in 1997, high-tech products composed two-thirds of Israel’s US $20.8 billion exports.

The Israeli Government, despite some justified complaints regarding its over-involvement, has been a major contributor to the success of Israel’s high tech industry. It was instrumental in creating the structure which encouraged and backed large numbers of projects, and helped turn ideas into marketable products. Establishment of the Office of the Chief Scientist, the Israel Export Institute, and Israel’s Venture Capital infrastructure can be credited to the foresight and determination of Israel’s government.

The Office of the Chief Scientist was created in the early 70’s to encourage R&D-based export-oriented industries. The Chief Scientist’s emphasis was originally centered on technological innovation. However, an important transformation occurred in the early 80’s, shifting the emphasis to product marketability.

In answer to the influx of technologically trained Russian immigrants, a technology incubator program was developed, under the aegis of the Chief Scientist. These immigrants had come with exciting ideas (which they were unable to develop in Russia), but without the resources to develop them or even a basic understanding of a market economy. Many of them, unable to find work in their fields of expertise, became street musicians and street cleaners.

The goal of the incubators was to employ these immigrants, while turning technological concepts into commercial successes through a framework of support and financial aid. Once accepted into this scheme, entrepreneurs are expected to complete development of their products within 2 years and to locate required financing, in order to continue development of their companies. Their obligation to return government loans is based on their future success.

The Israel Export Institute currently works with approximately 3,000 high tech start-ups, offering seminars and workshops on every relevant topic, focusing especially on marketing and management. The Institute also initiates contacts with foreign investors and potential JV partners, and rents space in relevant worldwide exhibitions, encouraging and assisting start-ups to participate. According to Eyal Meshulam, Marketing Division/ Start-Up Companies, "The Israeli High Tech scene is a well-spring of ideas, innovation, brains, and technology. For investors, the ideal combination is Israeli R&D, innovation and improvisation, together with US-style management and marketing."

The BIRD Foundation, the Israel/US Bi-national Industrial Research & Development Foundation, administered by the Chief Scientist in conjunction with theUS standards institute, promotes partnerships between Israeli and US companies. Today, most start-ups understand that sales and marketing is best managed from the US, and most expect to open US offices for this purpose.

Criteria have gradually shifted from emphasis on product marketability to emphasis on quality of management and the CEO’s vision and strategy. Additional bi-national R&D foundations have been established with Canada, Germany and Singapore. Israel also benefits from R&D cooperation with the European Union.

Enrollment in Business Schools is booming. Among the ten institutions offering MBA programs are: the Tel Aviv University; the Hebrew University inJerusalem; a number of small private colleges; and, branches of foreign schools, whose courses are taught in English. Today’s entrepreneurs typically complete both engineering degrees and MBAs.

ISEMI was established as an alternative to standard MBA programs whose curricula generally emphasize the theoretical at the expense of real-world implementation. Through a hands-on approach, which is coupled with a rigorous academic program, ISEMI’s lecturers guide students through situations they will actually face as entrepreneurs of technology start-ups.

The Israeli government can be credited with creating the underpinnings for the VC community in Israel. Yozma ("Initiative" in Hebrew) a venture capital fund, was established by the government with an initial sum of $100m, in order to assist technological start-ups.

Within six years, after an impressive record of success, the government sold its stake (at a substantial profit), leaving Yozma to become the basis for the more than 150 VC funds currently operating in Israel. Many of these funds were created with foreign partners and act as conduits through which a great deal of money is now flowing into Israel.

During the last two years, an astounding $2.7 billion was under management. Israeli VCs that have teamed with US co-investors have benefited from the opportunity to springboard their start-ups into the vast US market.

The success of Israel’s high-tech industry has lead to a number of trends surrounding the venture capital firms/funds that support it. Venture capital funds are getting larger. In 1998, Israel VCs raised $670 million, almost 70% more than two years earlier, and over 300% more than they raised in 1992. This increased size allows VCs to invest in, and lead, companies requiring significant inputs of funds. In fact, the size of capital raising rounds is increasing. In the past, capital raising rounds were typically $3-5 million; recently, they are in the neighborhood of $8-12 million.

One industry expert anticipates a consolidation in the industry, leading, ultimately, to a smaller investment community which will be made up of the strongest and most stable VCs. Included among them are: Polaris Fund II ($125m); Gemini Israel II ($110m); Genesis Partners ($90m); and Kardon Technology Ventures ($75m).

The Israeli VC community has traditionally shied away from seed-money investments, preferring more risk-free ventures. According to Micky Bronfeld, a successful investment banker, VCs have typically built safe portfolios and have taken key positions on the Boards of the companies in which they invest. In this way, VCs control a great deal of what is happening in Israel’s high tech community. Though money is available for start-ups that have reached more advanced stages of development, Bronfeld says that some investors are demanding lower pre-money valuations, forcing cash-strapped start-ups to settle for less. In effect, this has opened the way for new foreign investors to participate in potentially lucrative opportunities.

Exciting new transactions are being announced almost daily, many of them involving the purchase (or partnering) of Israeli start-ups by industry giants.

According to Amir Gilboa, manager of a consulting firm focusing on the high-tech industry, "Israeli start-ups tend to adopt an M&A exit strategy, due both to their great distance from major markets and to their lack of appropriate resources. This strategy usually creates lower value than the potential value that would have been achieved had the company adopted an IPO exit strategy.

They also tend to focus on well-defined areas, having understood that a clear focus is the key to a successful venture. However, this tendency may change in the near future, as more resources become available and more management experience is gained.

Though many foreign VCs have either set up offices in Israel or have joined Israeli VC firms, US companies have been, for the most part, slower to invest in Israel than their European and Japanese counterparts. It is generally accepted that this reluctance is due in part to geographical distance. Typically, if US investors can’t get to a board meeting within an hour, they prefer not to invest.

Despite this hesitance, over 200 US companies have already either invested in Israeli companies, built subsidiaries in Israel, or sub-contracted work to high-level Israeli technology companies. Some familiar names include Motorola, Intel, IBM, Johnson & Johnson, Sun, Cisco, and Texas Instruments.

In examining Israel’s high-tech environment, one can compare it to that of Singapore. They are both within the same proximity to their major markets (U.S.and Europe), they both aspire to technological leadership, and both lack a truly global presence in the form of nationally-known, world-wide companies.However, the two have a number of significant differences. First and foremost is the Israeli’s penchant for risk. Israeli’s are, by nature, not risk averse.Perhaps this is a result of living in an environment that is itself risky. Singaporeans, in contrast, are very risk averse, wishing to avoid any shame that may result from failure. Israeli’s are IPO-oriented when it comes to exiting their ventures. Singapore, however, has a family-based culture, and prefers not to discharge ownership to a large number of non-family members. This also explains why the abundant capital resources available to Singaporeans have gone relatively untouched over the years, whereas Israeli high-tech entrepreneurs have only recently benefited from the availability of capital.

The benefits of investing in Israel are becoming more widely recognized. International attention is being focused on Israel’s modern infrastructure of roads, airports, and ports; its impressive telecommunications system; its sophisticated banking community; its strong judicial system and world class legal community.

Not less important is a labor pool offering the world’s highest proportion of scientists and engineers plus a growing cadre of experienced high tech managers with impressive histories of start-up successes.

Uniquely positioned to enjoy the benefits of Free Trade Agreements with the US, the European Union and EFTA, Israel is able to act as a bridge between these markets. Optimism abounds and has been further fueled by the expectation that a newly elected government will soon get the peace process back on track, thus making Israel even more attractive for the international investment community.

In order to attract the investment community, Israeli entrepreneurs must dedicate themselves, not only to their ventures, but to advanced training and increased awareness of the industry and environment within which they operate.